Interviewee: Jason Steuerwalt
Interviewer: Mike Pacitto
Date: October 23, 2024
Slides 1-4:
Hi everyone, I’m Mike Pacitto with iM Global Partner. Thanks for joining us for this Q3 2024 video update on the iM Global Partner Alternative Strategies Fund [tickers: MASFX, MASNX]. I’m joined as always by Jason Steuerwalt, Head of Alternatives here at iM Global Partner and Portfolio Manager for the fund.
After a brief update on some selected metrics, we’ll dive into each of the underlying strategies for more in-depth commentary on performance, positioning and outlook. We appreciate your time and hope you find it well-spent.
Slide 5: In terms of allocation, our tactical overweight to the DoubleLine Opportunistic Income strategy remains intact and remains from our perspective very attractive. Otherwise, the underlying distinctive orientation of the fund – a diverse group of separate account strategies unique to MASFX with low inter-correlation to each other – continues with six overall managers and strategies.
Slide 6:
Here’s year-by-year performance going back to 2014. In general, you’ll see that the fund has consistently outperformed the Agg Bond index, as well as the Morningstar peer group, since inception.
That delivery of outperformance has continued so far this year, as MASFX has a sizable outperformance spread over core bonds year to date 2024 as well as against the category, although the AGG did have a stronger Q3.
Slide 7:
More specifically this year, the fund is ahead of the Agg bond index by over 300 basis points through the end of Q3 – and is ahead of the Morningstar category as well by over 200 basis points.
Along those lines, while many clients use the fund as a core alternative fund, many other clients do use it more specifically as a diversifier for their bond portfolio. In this respect, the Alternative Strategies fund has really shined – historically since inception beating the Agg Bond index by over 200 basis points annualized – while maintaining a similar standard deviation volatility level and yield and very low correlation, thus providing real diversification benefits to bond allocations.
Slide 8:
And finally, getting more granular in terms of diversifying benefits against bonds, the fund’s downside average return has been less than a fifth of the Agg during down periods, with over three and a half times the up-capture – so net-net the upside/downside characteristics have been very favorable. This is why we see many consultants and institutional investors continue to like this strategy for immunizing so to speak their bond portfolios.
Okay Jason, a bit more on performance then let’s get more in-depth on the underlying managers and strategies.
Thanks, Mike.
Slide 9:
The Fund was up 2.8% in Q3, resulting in a 7.5% return YTD through the end of September, following an almost 6% gain in 2023. The fund was down a bit through the first couple weeks of October, but held up better than the Agg, which was down about a percent in the same period.
As you said, since many investors use the fund at least in part as a complement to core fixed income, we compare to the Agg, which had a monster Q3 for core fixed income, up over 5%. Even with that big quarter, the fund was still about 300bps ahead of the Agg YTD, and that spread has widened out a little through the first weeks of October. We like that level of outperformance this year, and over the trailing 3 years, the fund has beaten the Agg by over 700bps.
Slide 10:
As a reminder, the strategy Blackstone (formerly DCI) manages for our fund consists of a long-short market neutral CDS portfolio and a cash bond sleeve that’s predominantly HY, where credit beta and interest rate duration are hedged to low levels. The intention is for individual security selection to drive performance over time rather than rates or credit spreads.
We like this strategy since it adds some diversity in approach, using a systematic, model-driven process, as well as uncorrelated return potential. It was up almost 5% in the terrible market environment of 2022, up almost 8% in 2023, which was of course a much better year for risk assets. In Q3 it was up about 2%, putting it up almost 5% for the year. So it’s done well in negative and positive markets, and continues to chug along.
As we note here, the low spread level in credit markets somewhat limits the upside since the strategy is market neutral on the CDS side and doesn’t use massive gross exposure to stretch for returns, and the long bond side is hedged to low rate and credit sensitivity. However, as I mentioned last time, the dispersion between model-implied credit spreads and market spreads (adjusted for absolute spread level) is towards the upper end of its historical range, which means there’s a lot of relative mispricing to capture.
But since the strategy is relatively defensively positioned, underweight low quality and declining quality names, it should provide a hedge in a declining market, with the potential for positive absolute returns.
That tilt away from high-spread, high-risk names was a challenge this quarter, as CCC bonds were up over 11%, while BBs were only up 4 and change, which makes the strategy’s 2% return for the quarter more satisfying.
Slide 11:
We tactically overweighted DoubleLine’s sleeve at the beginning of 2023, on the belief that the return profile was quite asymmetric in our favor, and it’s finally playing out. The sleeve was up almost 5% in Q3, helped by the Fed finally cutting rates by 50bps. The portfolio resulting in a nearly 9% gain YTD and almost 17% over the trailing year.
Nearly every sector in the portfolio generated positive returns, with the top-performing sectors consisting of longer duration assets in Agency MBS as well as non-Agency RMBS. The portfolio’s exposure to securitized credit sectors outperformed over the period as these assets continued to provide high interest income and benefitted from credit spread tightening.
Bank loans and (CMBS) were the only sectors that were negative on the quarter. With the Fed rate cut, the expected interest income for floating rate assets declined, contributing to wider spreads and a rotation out of leveraged loans.
Non-Agency RMBS continues to be the largest allocation at about one-quarter of the portfolio, followed by CLOs at and CMBS at about 20% each. Overall, the securitized credit segments account for about 2/3 of the portfolio and yields over 9%, while the government backed segments account for over 30% and yield over 6%. Corporates are less than 2% of the portfolio. As noted, the yield on the portfolio is about 8.5% with a duration of about 4.5.
Slide 12:
2023 was a challenging year for this strategy, with a lot of volatility, ending down about 4%. Things turned around dramatically through the first half of this year, with gains of over 14%. That reversed a bit in Q3, as the strategy was down over 2%, leaving the sleeve still up over 11.5% on the year, which is quite good in the context of the broader managed futures industry.
To slightly oversimplify, gains through the first half of the year came from being long equities, and short the Japanese yen. Q3 changed that, with the yen causing significant losses as the carry trade unwound dramatically in early August. As rates fell significantly, the strategy also suffered losses from the short bonds positioning, which had been close to break-even through the first half of the year. Reasonably good gains in equities and commodities, weren’t enough to offset the losses.
The portfolio positioning has shifted dramatically in response to the significant changes in markets. The short in the Japanese yen has been significantly reduced to an almost flat position, while the duration trade has morphed from a high conviction short to a significant, though not huge, long position. Commodities are just slightly long, and the most meaningful exposure is long equities, primarily US and developed international.
As we’ve mentioned before, we don’t just view this allocation as “crisis alpha,” but as an uncorrelated source of positive absolute returns that should be additive to performance over time. But it should do well in an extended market dislocation, which is of course a great feature in an alternative strategy. That said, right now, it would be hurt in a short, sharp equity market correction given how it’s currently positioned.
Slide 13:
FPA was up almost 4% in Q3, putting it up about 11 and a half YTD following last year’s high teens performance.
Contributors were well balanced, with five positions adding 30 to 50bps. They were a good mix of old economy and new economy names, as you see here. Alphabet was the only real material detractor, costing about 50bps. The collection of positions in the McDermott International capital structure flipped back to the negative side this quarter, down around 20bps.
There was a good bit of activity in the quarter compared with the recent past, with new equity positions added in Echostar, home and security products company Fortune Brands, commercial kitchen appliance maker Hoshizaki, spirits manufacturer Pernod Ricard, and beauty products company Shiseido. The PMs trimmed Alphabet and Amazon, and eliminated a few names as well. This is consistent with a small theme we’ve discussed with them about cutting back some tech/internet names that have become richly valued and adding consumer names that were very expensive several years ago before rates rose dramatically.
Slide 14:
The Absolute Return strategy was up nearly 7% in the quarter, benefiting from falling yields across the Treasury curve and tightening spreads. That puts it up over 9.5% for the year and almost 17% over the trailing year. Despite the big quarter, the portfolio is still yielding over 6.5% with less than a 20% allocation to HY and while holding 9% cash.
The portfolio’s allocation to HY was the biggest contributor, adding over 200bps. IG and securitized added about 100bps each. Convertible bonds and equities, although they’re small allocations at less than 10% combined, collectively added almost 100bps as well. Duration management through futures also added close to a percent.
The strategy continues to be anchored by securitized credit, accounting for approximately one-third of the portfolio, while HY (19% net) and IG (17% net) account for the other largest exposures. Convertible bonds and equities together make up almost 9%, providing additional upside potential.
As a reminder, compared to DoubleLine, Loomis typically has a larger allocation to corporates vs securitized, owns a bit of yielding equities and convertibles, has significantly less in mortgages (particularly Agency MBS), and will typically hold more dry powder, which usually results in slightly lower yield and duration. So despite the credit-oriented nature of both portfolios, the DL and Loomis approaches and portfolios are pretty different, which has produced complementary return patterns.
Slide 15:
The Water Island sleeve of the fund bounced back in Q3, gaining almost 3%, bringing YTD performance to up 2.5%. Both sub-strategies contributed positively, with merger arb contributing about 2.3% gross, and special situations contributing almost 0.4% (with positive attribution from both equity and credit).
You can see the top contributors here, with a couple in the healthcare space. The biggest detractors for the most part continue to be based on political and/or regulatory risk, with the US Steel purchase by a Japanese company obviously a hot-button political issue especially in an election year, and Albertsons-Kroger subject to FTC challenge. But there’s also the odd idiosyncratic issue, with the Revance Therapeutics acquisition imperiled because of a dispute with a Swiss company whose products Revance distributes.
The portfolio is still heavily tilted toward merger arbitrage at about 85% of long exposure, although as we mentioned previously, there has been an increase in credit special situations. That segment, which is about 15% of the portfolio, continues to contribute positively. Our recent discussion with the PMs indicated that we should expect to continue seeing this allocation in the teens, as they believe they’re able to generate similar (though potentially not quite as high) expected returns as the equity merger arb part of the portfolio, while taking less risk.
While average gross deal spreads contracted slightly over the last quarter, Water Island still believes the current annualized deal spreads remain very attractive. In the months ahead, lower rates may even help bolster the merger arb strategy’s return potential by leading to stabilizing or even increasing standalone values for M&A targets. We’ve talked about the regulatory environment a lot over the last couple of years given the high number and aggressiveness of challenges, but it has resulted in a less crowded field of other investors in the space at a time when deals are picking back up, corporate confidence is high, there’s a ton of PE dry powder, and credit is widely available at a decreasing cost given tight spreads and lower base rates. So we’re expecting a good environment for the strategy.
Slide 16:
To return briefly to the Agg comparisons, the fund has beaten the Agg by about 14 percentage points over the last 5 years. Since the fund’s high point at the end of August 2021, the outperformance is about eight percentage points, and since the Agg’s peak at the end of July 2020, the outperformance is over 20 percentage points.
Despite that outperformance, the long-biased fixed income managers in the fund, DoubleLine and Loomis Sayles, still have very attractive portfolios on an absolute basis and obviously relative to the Agg. Between them, there’s a blended yield-to-maturity of over 7.8% at quarter end (vs 4.2% for the Agg) with a duration just over 4, enough to provide some buffering a risk-off scenario, but without nearly as much interest rate risk as the Agg’s 6.2 duration in the event rates surprise to the upside, as we’ve seen so far in October.
Although I’m saying the same thing as last quarter, it remains true: stepping back, we have a really attractive relative and absolute yield from DoubleLine and Loomis Sayles, plus a very nice annualized deal spread with relatively short average deal duration from Water Island. Those three together make up almost 60% of the fund, and they’re complemented by the smaller, opportunistic, go-anywhere FPA portfolio that still has a lot of dry powder.
The remainder is comprised of the Blackstone Credit and DBi strategies that have very low correlation to other managers and traditional assets, and both of which we’ve seen perform well in a positive market environment, but importantly have historically preserved capital and even generated positive returns in bad markets. The larger allocation here, especially to DBi, which has higher potential upside in extended dislocations, makes the fund more robust across various market environments. But for now, we’re still benefitting from the tailwind of those healthy yields and deal spreads while getting good contributions from other sources as well. It’s been satisfying to see the rebound we expected playing out, and we think there’s more to go.
Back to you, Mike.
Slide 17-18:
Thanks Jason.
I’ll close here by saying thanks to all of our clients and to our prospective clients for your confidence and interest in the iMGP Alternative Strategies Fund. If you have more questions about the strategy, would like further information or a call with us please don’t hesitate to reach out – just send us an email at: [email protected]